Fed Stress Tests Show Cracks in Fortress Balance Sheets

Written by: Antoine Gara03/07/13 - 5:58 PM EST

Tickers in this article:
BAC C FITB GS JPM MS WFC

NEW YORK ( TheStreet) -- A year after having their initial 2012 capital plans were rejected by the Federal Reserve , Citigroup(C) and Fifth Third Bancorp (FITB) appear to be among the best capitalized banks, according to the regulator.

In stress test results released on Thursday, Citigroup and Fifth Third now are projected by the Fed to have common capital ratios in excess of 8% in a stressed economic scenario of a deep recession, 12%-plus unemployment, a 20% slump in housing prices, and a 52% drop in U.S. stock markets.

Notably, while Citigroup and Fifth Third have emerged with the Fed's imprimatur on the heels of Thursday's results, lenders such as JPMorgan(JPM) , Bank of America (BAC) and Wells Fargo (WFC) now appear more vulnerable to a deep economic crisis, on a relative basis.

"It is a little surprising that Citi has done so well while JPM slipped," wrote Peter Tchir, the head of TFMarket Advisors and a former credit trader at Deutsche Bank and Royal Bank of Scotland, in a note to clients.

Wells Fargo's Tier 1 common equity ratio under the Federal Reserve's "severely adverse scenario" would fall to just 7%, well below those of Citigroup and Fifth Third, but still significantly above the 5% minimum threshold to pass stress tests.

Bank of America would whether the Fed's severe scenario with a projected minimum 6.8% Tier 1 common ratio, while JPMorgan's minimum stressed ratio of 6.3% indicates it's the most vulnerable of the "big four" U.S. banks to an economic downturn.

JPMorgan's underperformance under the severely adverse scenario may reflect the hit the bank took in 2012 when it recorded a trading loss in excess of $6 billion, which caused the nation's largest bank by assets to suspend a $15 billion share repurchase plan.

"Ironically (or maybe not ironically) the Whale trade had been great in the stress tests the way it was designed, and maybe that is why JPM did worse this time around," Tchir wrote, referencing a failed credit derivative trade known as the 'London Whale.'

The bank's stress-test bill of health also may signal the cost of having extensive trading and investment banking operations, where high amounts of capital are now mandated by regulators.

In a stressed scenario, Morgan Stanley (MS) and Goldman Sachs (GS) would have capital ratios below 6%, but above the minimum 5% threshold. A press releases by Morgan Stanley shows the bank calculated 1% more capital than the Federal Reserve, a 6.7% common equity ratio, in a stressed scenario.

Roughly a quarter of overall losses in a stressed scenario would come from counterparty exposures and trading losses. Overall, in a stressed scenario, Wall Street would post roughly $194 billion in losses, according to the Fed's calculations, with Bank of America leading the way with a $51.8 billion loss.

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